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Let market forces weed out less productive firms: MTI study

Even as the government doles out support to help companies restructure, competitive market forces should be allowed to work through the economy, as these help to weed out less productive firms, said a Ministry of Trade and Industry (MTI) study released on Wednesday.

EVEN as the government doles out support to help companies restructure, competitive market forces should be allowed to work through the economy, as these help to weed out less productive firms, said a Ministry of Trade and Industry (MTI) study released on Wednesday.

By letting market forces work, Singapore can achieve higher productivity growth in two ways: One is when labour is re-allocated from less-productive firms to more productive ones, a process called the positive re-allocation effect; the other is when less productive firms exit and make way for new and more productive entrants, in a process called the positive churn effect.

The findings of the study, which focused on the manufacturing sector, showed that collectively, both these effects play a significant role in improving productivity. This was most apparent after the global financial crisis (between 2009 and 2013), when re-allocation and firm churn effects accounted for 48 per cent of manufacturing productivity improvements.

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Even in the post-crisis period, the re-allocation effect continued to contribute to productivity improvements. MTI's study noted that the recent tightening of manpower policies has tilted the balance toward more productive firms with higher capital intensity; because these firms can afford to pay higher wages, they have also been able to increase their employment shares.

The four economists behind the study said: "Our findings thus suggest that positive firm churn (where less productive firms exit and more productive firms enter) and the net re-allocation of labour to more productive firms are important channels to achieving higher productivity growth in the Singapore economy.

"Government policies should hence continue to encourage firms to innovate and adapt, even while allowing competitive market forces to work," added the team, which noted that there is room to conduct similar studies on the services and construction sectors.

Their findings come amid criticism that the government has inadvertently hampered restructuring efforts by providing too much and too broad support for firms - thereby propping up "zombie" companies that would otherwise have failed.

Asked by The Business Times if the government, in light of the study's findings, will now allow market forces to take hold to a greater extent, MTI permanent secretary Loh Khum Yean replied: "I don't think the feature article suggests a change in policy. I think it's an analysis of the firm churn we've witnessed, and the nature of firms that have entered vis-a-vis those which have exited.

"It's a healthy phenomenon in any well-functioning market economy. The government remains committed to assisting firms to restructure to upgrade their operations, and it will do so in a judicious and purposeful manner."

On a more micro level, the study also found that firm churn was higher in segments such as printing machinery and systems - likely due to a higher number of small- and medium-sized enterprises or SMEs in these segments.

Segments such as petroleum and aerospace, in contrast, had lower entry and exit rates.

Firms in the lower productivity quartiles were found to be more likely to exit, while entry firms tended to start in the lower-productivity quartiles.